242 section 5 The Financial Sector
Tackle the Test: Multiple-Choice Questions
- Suppose, for simplicity, that a bank uses a single interest rate
for loans and deposits, there is no inflation, and all unspent
money is deposited in the bank. The interest rate measures
which of the following?
I. the cost of using a dollar today rather than a year
from now
II. the benefit of delaying the use of a dollar from today
until a year from now
III. the price of borrowing money calculated as a percentage
of the amount borrowed
a. I only
b. II only
c. III only
d. I and II only
e. I, II, and III - If the interest rate is zero, then the present value of a dollar
received at the end of the year is
a. more than $1.
b. equal to $1.
c. less than $1.
d. zero.
e. infinite.
3. If the interest rate is 10%, the present value of $1 paid to you
one year from now is
a. $0.
b. $0.89.
c. $0.91.
d. $1.
e. more than $1.
4. If the interest rate is 5%, the amount received one year from now
as a result of lending $100 today is
a. $90.
b. $95.
c. $100.
d. $105.
e. $110.
5. What is the present value of $100 realized two years from now if
the interest rate is 10%?
a. $80
b. $83
c. $90
d. $100
e. $110
Tackle the Test: Free-Response Questions
- a. Calculate the net present value of each of the three
hypothetical projects described below. Assume the interest
rate is 5%.
Project A: You receive an immediate payoff of $1,000.
Project B: You pay $100 today in order to receive $1,200 a
year from now.
Project C: You receive $1,200 today but must pay $200 one
year from now.
b. Which of the three projects would you choose to undertake
based on your net present value calculations? Explain.
Answer (5 points)
1 point:Project A net present value: $1,000
1 point:Project B net present value: −$100+($1,200/1.05)=$1,042.86
1 point:Project C net present value: $1,200 − ($200/1.05)=$1,009.52
1 point:Choose project B.
1 point:It has the highest net present value.
- a. What is the amount you will receive in three years if you loan
$1,000 at 5% interest?
b. What is the present value of $1,000 received in three years if
the interest rate is 5%?